Welcome to part two of “The Ultimate Beginner’s Options Crash Course To Be Consistently Profitable” by Options with Davis. In this video, you will learn valuable insights and techniques for becoming a consistently profitable trader in options. The video is part of a series that covers various aspects of options trading, and it is recommended to watch part one for a comprehensive understanding of the topic.
In this second part, the video discusses high-probability consistent income strategies, recurring profits with the wheel strategy, and mastering covered calls in options trading. It explains the concepts of expected move, intrinsic and extrinsic value, and the Greeks in options trading. The video also recommends three safe option strategies for beginners: the bull put spread, bear call spread, and iron condor. Additionally, it emphasizes the importance of capital allocation and risk management in options trading. If you want to become consistently profitable when trading options, make sure to watch this video and get your copy of The Options Income Blueprint for free.
Recap of Part 1
Overview of Part 1
In Part 1, we covered the fundamentals of options trading, including an introduction to puts and call options, understanding the concept of in-the-money, at-the-money, and out-of-the-money options, as well as the intrinsic and extrinsic value of options. We also discussed the Greeks – delta, gamma, theta, and vega – and their importance in options trading. Additionally, we learned about the expected move, which is the market’s expected range over a given period.
Key concepts covered in Part 1
The key concepts covered in Part 1 were:
- Puts and call options
- In-the-money, at-the-money, and out-of-the-money options
- Intrinsic and extrinsic value
- The Greeks (delta, gamma, theta, and vega)
- Expected move
Now that we have recapped Part 1, let’s dive into the concepts and strategies discussed in Part 2.
Understanding Options Trading Concepts
Expected move
The expected move is a key concept in options trading. It represents the market’s expected range over a given period. It is calculated using historical data and implied volatility. The expected move helps traders make informed decisions about which options to trade and at what strike price.
Historically, the market has tended to stay within the expected move range more often than expected, providing an opportunity for option sellers to profit. While the theoretical expectation is that the market will stay within the expected move 68% of the time, historical data suggests that it has stayed within this range 71% to 85% of the time. This discrepancy indicates that implied volatility tends to overstate the market’s actual volatility, allowing option sellers to have an edge.
Intrinsic and extrinsic value
Intrinsic value is the inherent value of an option, determined by the difference between the option’s strike price and the current market price of the underlying asset. If an option has intrinsic value, it is said to be in-the-money. Intrinsic value represents the profit that could be realized if the option were exercised immediately.
Extrinsic value, also known as time value, is the remaining value of an option beyond its intrinsic value. It is influenced by factors such as time decay (theta), implied volatility, and the probability of the option moving in-the-money before expiration. Extrinsic value can be thought of as the premium that option buyers are willing to pay to potentially profit from future price movements.
Understanding the balance between intrinsic and extrinsic value is crucial in options trading, as it can determine the profitability of a trade and help traders select the most appropriate strategies.
The Greeks in options trading
The Greeks – delta, gamma, theta, and vega – are a set of risk measures used to assess the sensitivity of options to changes in various factors. They provide valuable insights into the behavior of options and help traders manage their risk.
- Delta: Delta measures the rate of change in the option price relative to changes in the price of the underlying asset. It indicates how much an option’s price is expected to move in response to a $1 change in the underlying asset’s price.
- Gamma: Gamma measures the rate of change in an option’s delta relative to changes in the price of the underlying asset. It shows how sensitive the delta is to changes in the underlying asset’s price.
- Theta: Theta measures the rate of time decay in an option’s premium. It indicates how much value an option loses with the passage of time, all other factors being equal.
- Vega: Vega measures the sensitivity of an option’s price to changes in implied volatility. It indicates how much an option’s price is expected to move in response to a 1% change in implied volatility.
Understanding the Greeks and their implications can help traders make informed decisions about which options to trade, adjust positions as needed, and manage risk effectively.
Difference Between Selling Premium and Buying Premium
Explanation of selling premium
Selling premium, also known as option selling or writing options, involves taking a position as the option seller. As an option seller, you collect the premium upfront from the buyer in exchange for assuming a certain level of risk. By selling options, you have the potential to profit if the options expire worthless or if the price of the underlying asset stays below (for call options) or above (for put options) the strike price.
Selling premium can be a high-probability strategy as it relies on the concept of probabilities and the time decay of options. Option sellers aim to take advantage of inflated implied volatility and the fact that options tend to expire worthless most of the time. However, it’s important to understand the risks involved in option selling and to have proper risk management strategies in place.
Advantages of selling premium
There are several advantages to selling premium:
- Higher probability of profit: As an option seller, you have a higher chance of profiting from your trades compared to buying options. This is because the majority of options expire worthless.
- Opportunity for consistent income: By selling options consistently, you can potentially generate regular income from the premiums collected. This can provide a steady stream of cash flow, especially when utilizing strategies that have a high win rate.
While selling premium can offer these advantages, it’s essential to understand the risks and to manage them effectively. Options can be complex financial instruments, and it’s crucial to have a solid understanding of the strategies and markets you are trading.
Safe Option Strategies for Beginners
The bull put spread
The bull put spread is a bullish options strategy that involves selling a put option with a higher strike price and buying a put option with a lower strike price. This strategy allows traders to profit from a moderately bullish outlook on the underlying asset while limiting their downside risk.
By selling the higher-strike put option, traders collect a premium, which helps reduce their overall risk. The lower-strike put option acts as a form of insurance, limiting potential losses if the market moves against the trade. The goal of the bull put spread is for the underlying asset’s price to stay above the higher strike price, allowing the options to expire worthless and the trader to keep the premium collected.
The bull put spread is a popular strategy for beginners as it provides a defined risk-reward profile and can be implemented with a lower investment compared to other strategies.
The bear call spread
The bear call spread is a bearish options strategy that involves selling a call option with a lower strike price and buying a call option with a higher strike price. This strategy allows traders to profit from a moderately bearish outlook on the underlying asset while limiting their risk.
By selling the lower-strike call option, traders collect a premium, which helps reduce their overall risk. Buying the higher-strike call option provides protection, limiting potential losses if the market moves against the trade. The goal of the bear call spread is for the underlying asset’s price to stay below the lower strike price, allowing the options to expire worthless and the trader to keep the premium collected.
The bear call spread is another strategy that beginners can consider, as it provides a defined risk-reward profile and can be implemented with a lower investment compared to other strategies.
The iron condor
The iron condor is a neutral options strategy that involves selling both a bear call spread and a bull put spread on the same underlying asset. This strategy is suitable in situations where the trader expects the price of the underlying asset to remain within a certain range.
By selling both the bear call spread and the bull put spread, traders collect premiums from both trades. The goal of the iron condor is for the underlying asset’s price to stay within the range defined by the strike prices of the options, allowing all the options to expire worthless and the trader to keep the premiums collected.
The iron condor is a more advanced strategy compared to the bull put spread and bear call spread. It requires a good understanding of options pricing and the ability to identify suitable range-bound market conditions. Beginners may want to start with the simpler bull put spread and bear call spread strategies before attempting the iron condor.
Using the Stochastic Oscillator in Options Trading
Determining market conditions with the stochastic oscillator
The stochastic oscillator is a technical analysis tool that helps traders identify overbought and oversold conditions in the market. It consists of two lines – %K and %D – which fluctuate between 0 and 100. The %K line represents the current closing price relative to the high-low range over a specified period, while the %D line is a smoothed moving average of %K.
In options trading, the stochastic oscillator can be used to determine market conditions and potential turning points. When the oscillator is above 80, it indicates that the market is overbought, and a potential reversal or pullback may occur. Conversely, when the oscillator is below 20, it suggests that the market is oversold, and a potential reversal or bounce may occur.
By identifying overbought and oversold conditions, options traders can make more informed decisions about when to enter or exit trades. It’s important to note that the stochastic oscillator is just one tool among many in a trader’s arsenal, and it should be used in conjunction with other technical indicators and analysis techniques.
Identifying support and resistance levels
Support and resistance levels are key areas on a price chart where the price of an asset has historically reversed or stalled. These levels can act as barriers to further price movement and provide valuable information for options traders.
The stochastic oscillator can be used to identify potential support and resistance levels. When the oscillator reaches extreme levels, such as above 80 or below 20, it can suggest that the market is nearing a potential reversal or bounce. Traders can use these levels as reference points for placing trades or adjusting existing positions.
Additionally, the stochastic oscillator can help traders confirm the strength of support and resistance levels. If the oscillator shows divergence – where the price of the asset moves in the opposite direction of the oscillator – it can indicate that the support or resistance level is weakening and may not hold.
By combining the stochastic oscillator with support and resistance analysis, options traders can gain a better understanding of market conditions and make more informed trading decisions.
Closing Trades at 21 Days to Expiration
Reasons for closing trades
Closing trades at 21 days to expiration is a common practice among options traders. There are several reasons why traders choose to close their trades at this point:
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Time decay: As an option approaches expiration, the rate of time decay (theta) accelerates. By closing trades at 21 days to expiration, traders can capture a significant amount of time decay, which can increase the profitability of their trades.
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Reduced risk: By closing trades before expiration, traders eliminate the risk of potential adverse market movements in the final days or hours before expiration. This is particularly important for options sellers, as adverse market movements can result in significant losses.
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Capital allocation: Closing trades at 21 days to expiration allows traders to free up capital for new trading opportunities. By closing existing trades, traders can allocate their capital more efficiently and take advantage of other potentially profitable trades.
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Avoiding assignment: Closing trades before expiration also helps to avoid the risk of being assigned on an option. When an option is assigned, the trader is obligated to buy or sell the underlying asset at the strike price. By closing trades before expiration, traders can reduce the likelihood of assignment and mitigate potential losses.
Reducing losses and potential assignment
Closing trades at 21 days to expiration can help traders limit losses and reduce the risk of potential assignment. As an option approaches expiration, its value is largely determined by its intrinsic value, which is the difference between the strike price and the current market price of the underlying asset. By closing trades before expiration, traders can minimize the impact of adverse market movements on the value of their options.
In addition, closing trades before expiration reduces the risk of being assigned on an option. Being assigned can result in additional costs and potential losses, especially if the market moves against the trader’s position. By closing trades early, traders can avoid the uncertainty and potential losses associated with assignment.
It’s important to note that the decision to close a trade at 21 days to expiration may vary depending on the specific strategy, market conditions, and individual trading preferences. Traders should carefully consider their risk tolerance and objectives before deciding when to close their trades.
Importance of Capital Allocation and Risk Management
Understanding capital allocation
Capital allocation refers to the process of distributing an investor’s available capital among different assets or strategies. In options trading, effective capital allocation is crucial for managing risk and maximizing returns.
Proper capital allocation involves diversifying investments across different option strategies, sectors, and underlying assets. By spreading capital across a range of trades, traders can reduce the impact of potential losses from individual trades and increase the potential for overall profitability.
Capital allocation should also take into account the risk-reward profile of each trade. Trades with higher potential returns may require a smaller percentage of capital, while trades with lower potential returns may warrant a larger allocation. Balancing risk and reward is essential for long-term success in options trading.
Implementing proper risk management
Risk management is a critical aspect of options trading. It involves strategies and techniques aimed at limiting potential losses and preserving capital. By effectively managing risk, traders can protect themselves from excessive losses and ensure the longevity of their trading efforts.
There are several risk management techniques that options traders can employ:
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Setting stop-loss orders: A stop-loss order is an order placed with a broker to sell a position if the price reaches a predetermined level. By setting stop-loss orders, traders can limit their potential losses if the market moves against their positions.
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Diversifying trades: Diversification involves spreading trades across different assets, sectors, or strategies. By diversifying, traders can reduce their exposure to any single trade or market condition.
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Position sizing: Position sizing refers to determining the appropriate amount of capital to allocate to each trade. By carefully selecting position sizes, traders can manage risk and avoid overexposure to any single trade.
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Regular evaluation and adjustment: Risk management is an ongoing process that requires continuous monitoring and evaluation. Traders should regularly review their trades, adjust their strategies as needed, and be prepared to cut losses if necessary.
Implementing proper risk management techniques is crucial for long-term success in options trading. By managing risk effectively, traders can protect their capital and increase their chances of generating consistent profits.
Exploring the Bread Purchase Strategy
Purchase options for 72 cents or $162
One of the strategies discussed in the video involves purchasing options for either 72 cents or $162. This strategy is designed to take advantage of potential price movements in a specific underlying asset.
By purchasing options for a relatively low price, traders can potentially profit if the price of the underlying asset moves in the desired direction. The options provide leverage, allowing traders to control a larger position with a smaller investment.
The specific details of the strategy, such as the expiration date and strike price, were not provided in the video. Traders should carefully consider these factors before implementing the strategy and assess the risk-reward profile of the trade.
Benefits and risks of the strategy
The bread purchase strategy, as mentioned in the video, offers potential benefits and risks:
Benefits:
- Leverage: By purchasing options, traders can control a larger position than the premium paid. This provides the opportunity for significant profits if the price of the underlying asset moves favorably.
- Limited risk: The maximum risk in this strategy is the premium paid for the options. This means that potential losses are known upfront and can be managed through proper risk management techniques.
Risks:
- Time decay: As options approach expiration, their value erodes due to time decay. This means that if the price of the underlying asset doesn’t move as expected within a certain timeframe, the options may lose value.
- Volatility: Options are influenced by changes in implied volatility. If volatility increases significantly, it can have a negative impact on the value of the options.
- Uncertain market conditions: The success of this strategy relies on accurately predicting the direction of price movements in the underlying asset. If the market conditions don’t align with the trader’s expectations, the options may not be profitable.
Traders considering the bread purchase strategy should carefully evaluate these benefits and risks, conduct thorough analysis, and implement appropriate risk management techniques.
The Bear Call Spread Strategy
Using Stochastic indicators to determine market conditions
In the video, the bear call spread strategy is mentioned as a way to profit from a moderately bearish outlook on the underlying asset. The strategy involves selling a call option with a lower strike price and buying a call option with a higher strike price.
To determine market conditions for implementing the bear call spread strategy, the video suggests using Stochastic indicators. Stochastic indicators are a popular technical analysis tool used to identify overbought and oversold conditions in the market.
When the Stochastic indicators show that the market is overbought, it indicates a potential reversal or pullback may occur. This can align with the bearish outlook necessary for implementing the bear call spread strategy. By combining technical indicators like Stochastic with options strategies, traders can gain a more comprehensive view of the market and make more informed trading decisions.
Identifying resistance levels for strike prices
Another aspect of the bear call spread strategy mentioned in the video is the identification of resistance levels for selecting the strike prices. Resistance levels are areas on a price chart where an asset’s price has historically struggled to move above.
By identifying these resistance levels, traders can select strike prices for the call options that are likely to remain above the current market price. This increases the probability of the options expiring worthless and allows traders to profit from the premiums collected.
The combination of using Stochastic indicators to determine market conditions and identifying resistance levels helps traders make more informed decisions when implementing the bear call spread strategy. It provides a framework for selecting the strike prices and increases the chances of a profitable trade.
Conclusion
In Part 2 of the Ultimate Beginner’s Options Crash Course by Options with Davis, we delved deeper into options trading concepts, including the expected move, intrinsic and extrinsic value, and the Greeks. We also explored the difference between selling premium and buying premium, as well as safe option strategies for beginners.
The importance of using technical analysis tools like the stochastic oscillator to determine market conditions and identify support and resistance levels was highlighted. Additionally, we discussed the benefits of closing trades at 21 days to expiration and the significance of capital allocation and risk management in options trading.
Finally, we explored two specific strategies: the bread purchase strategy and the bear call spread strategy. These strategies provide opportunities for potential profits, but also come with their own set of risks.
By expanding your knowledge of options trading concepts, strategies, and risk management techniques, you can increase your chances of becoming a consistently profitable options trader. Remember to always conduct thorough analysis, implement proper risk management, and stay informed about market conditions to make informed trading decisions.